What is Amortization?
Amortization has two primary definitions. The first refers to the systematic repayment of a loan over time. The second is related to business accounting, where it involves spreading the cost of an expensive, long-term asset over multiple periods. Both concepts are explored in detail below.
Paying Off a Loan Over Time
When someone takes out a mortgage, car loan, or personal loan, they typically make monthly payments to the lender, which is one of the most common applications of amortization. Each payment consists of two parts: a portion for the interest on the loan and another portion that reduces the principal balance. As the principal decreases over time, the interest owed also decreases, as interest is calculated on the remaining balance. You can see this progression clearly in an amortization table.
Unlike amortized loans, credit cards usually involve revolving debt. This means that the outstanding balance can be carried from month to month, and repayment amounts can vary. To explore credit card payments further, you can use our Credit Card Calculator or the Credit Cards Payoff Calculator, which helps to plan a strategy for paying off multiple credit cards. Other examples of non-amortized loans include interest-only and balloon loans, where payments are structured differently. In an interest-only loan, only interest is paid for a period, while a balloon loan requires a large lump sum payment at the end of the term.
Amortization Schedule
An amortization schedule (also called an amortization table) details each periodic payment on an amortizing loan. Along with each calculation, the schedule provides both annual and monthly breakdowns. For each payment, a specific amount goes toward interest, while the remaining balance is applied to the principal. The schedule shows how much has been paid in interest and principal so far, as well as the remaining balance.
Basic amortization schedules don’t account for extra payments, though borrowers can still make additional contributions. These schedules typically don’t include fees and are designed for fixed-rate loans. They are not suitable for adjustable-rate mortgages, variable-rate loans, or lines of credit.
Spreading Costs Over Time
In business, amortization also refers to spreading the cost of expensive, long-lasting items over time. Businesses may purchase costly equipment, machinery, or buildings that are classified as investments. Rather than recording the full cost in a single period, businesses amortize these assets over their useful life. While this process is technically amortization, it’s often referred to as depreciation when it involves tangible assets like factories. For calculations related to depreciation, please visit our Depreciation Calculator.
Amortization in accounting more commonly applies to intangible assets such as patents or copyrights. Under U.S. law (Section 197), the value of these assets can be deducted periodically, either monthly or annually. Like other types of amortization, this process can be mapped out using an amortization schedule. Common intangible assets that are often amortized include:
- Goodwill, representing the reputation of a business
- Going-concern value, or the value of a business as a continuing operation
- Workforce in place, including employee experience and training
- Business records, operating systems, or customer information
- Patents, copyrights, formulas, designs, or similar intellectual property
- Customer-based intangibles, such as client relationships
- Supplier-based intangibles, including relationships with vendors
- Licenses, permits, or government-issued rights
- Non-compete agreements linked to acquisitions
- Franchises, trademarks, or trade names
- Contracts for the use of any items listed above
However, some intangible assets, such as goodwill with an indefinite lifespan or self-created intangibles, may not qualify for amortization for tax purposes.
Amortizing Startup Costs
In the U.S., business startup costs can be amortized under specific conditions. These costs must be incurred before the business becomes active and must qualify as deductible business expenses if they were incurred by an existing active business. Examples of startup costs include consulting fees, financial analysis, advertising, and payments to employees before the business officially starts operating. According to IRS guidelines, these initial costs must be amortized.
The IRS also outlines which assets are not considered intangible, such as interests in businesses or land, most software, or certain transaction costs where no gain or loss is recognized.